Life in the military and after comes with a certain amount of complexity and that extends to the financial parts of life too. Here are a few ways you might consider employing tax strategies and planning to make a big difference when it comes to your taxes.
Combat Zone Tax Exclusion (CZTE) & Foreign Earned Income Exclusion (FEIE)
While deployed to a combat zone, military members and civilian employees may be eligible to have some or all of their income excluded from taxable income. This means that deployments offer a unique and compelling opportunity to employ tax strategies that can have a significant and long lasting impact to what you pay in taxes now and well into the future. You can read about how to super charge your savings during deployment if you have a deployment coming up.
You may also find yourself living or working abroad in areas that are not considered combat zones. In those circumstances you may be eligible for the FEIE which can also significantly reduce your taxable income. The FEIE ensures that a portion of your income which is earned in foreign countries is not subject to U.S. taxes. If you happen to be working i a country that has a lower tax rate for you this election may be worthy of consideration.
State of Legal Residence (SLR) Rules
Being a member of the military typically comes with frequent moves across state lines. However, unlike a typical person in civilian life these moves do not obligate military members to change their State of Legal Residency (SLR) which is often their home of record. This provides a military member potential tax savings in the event that their effective state income tax rate for their SLR is lower than the state they are temporarily living in as part of their military service.
Military spouses have the option to change their SLR to match the service member's SLR too. This would mean that the household income gets a beneficial tax treatment for both spouses. However, this rule cuts both ways. If your SLR has a higher state income tax rate than where you are domiciled then you may be paying more in taxes than you have to.
Fortunately, the military has recognized that military members may not want to maintain their SLR as the same state as their home of record where they entered the military from. When a military member decides they want to change their SLR they need only demonstrate true intent of becoming a residence in that state by obtaining a driver's license, vehicle registration, paying taxes, voting or owning property there in the state they wish to become their new SLR.
This one change can have a major financial impact on the tax burden for military families. It can also have a major impact after a military member transitions to life as a veteran.
State Taxes for Veterans
After you have transitioned out of the military, the state you choose to call home can have a massive impact on your financial well-being based on the tax burden that state places on veterans. Among the many ways a state may favor veterans is through:
- State income tax on military pensions
- Property tax exemptions for certain veterans
- Exclusions or reductions for license and registration fees
- Business tax credits and exemptions
These benefits should be carefully scrutinized along with other opportunities and benefits you may find in each state.
Housing & Sustenance Allowances
Among the most tax-advantaged pay a military member can receive is their Basic Allowance for Housing (BAH) and their Basic Allowance for Sustenance (BAS). Both of these pays receive a tax-exempt status which means that a military members total compensation has a significantly reduced effective tax rate compared to their non-military contemporary receiving the same gross pay. What this means from a tax planning perspective is that tax strategies that take advantage of differences is effective tax rates throughout a person's lifetime can be employed while you are receiving these allowances. Notably, the inclusion of these allowances make Roth TSP & Roth IRA contributions a little more attractive on a dollar-for dollar basis compared to someone with the same salary that is being taxed on all of their income.
VA Disability & Compensation Benefits
When a veteran receives compensatory disability from the VA that income is not taxable at either the state or federal level. Having access to non-taxed cash flow throughout the course of your life as a veteran opens up a number of tax planning possibilities other people will never have, or at least will not be able to execute as efficiently. In addition to the direct tax treatment of this compensation, having some service connected disability also unlocks a host of other benefits like free access to national parks, exemption from PMI on a primary residence mortgage, reduced rates and better access at the VA healthcare system to name a few.
